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SCIENTIFIC STOCK 
SPECULATION 

By CHARLES H. DOW 



With Introduction and Notes 
By G. C SELDEN 



A condensed statement of the principles upon which 

successful stock speculation must 

be based. 



The MAGAZINE of WALL STREET 
NEW YORK 






Copyright, 1920 

By 

The MAGAZINE of WALL STREET 



JUN -I 1920 

©CI.A571164 



CONTENTS. 

Chapter Page 

Introduction 5 

I. Scientific Speculation 1 1 

II. The Two General Methods of 

Trading 17 

III. Three General Lines of Reasoning 2^ 

IV. Swings Within Swings 29 

V. Methods of Reading the Market 33 

VI. The Operation of Stop Orders 39 

VII. Cutting Losses Short 45 

VIII. The Danger in Overtrading 51 

IX. Methods of Trading 57 

X. The Out of Town Trader 67 

XI. The Short Side of the Market y^ 

XII. Speculation for the Decline 79 

XIII. Concerning Discretionary Accounts 85 

XIV. The Liability for Loss 91 

XV. The Recurrences of Crises 97 



INTRODUCTION 

By G. C. Selden 

MR. CHARLES H. DOW, formerly the 
head of the Dow-Jones News Bureau, 
Wall Street's largest news gathering 
agency, had unusual opportunities for observ- 
ing the methods of traders in stocks, both suc- 
cessful and unsuccessful. And it may be added 
that at the time of his death it was found that 
he had profited substantially by his accumulated 
knowledge. 

About the year 1902 he wrote for the Wall 
Street Journal a series of articles on the science 
of stock speculation which attracted much at- 
tention. They were reprinted in book form, but 
the book has long been out of print. These ar- 
ticles are here reproduced just as he wrote 
them. 

A good deal of water has flowed under the 
bridge since 1902, but there has been no change 
in the essential principles which Mr. Dow 7 laid 
down. This is in itself a strong tribute to their 
permanent value, when we consider the great 
changes that have taken place not only in the 



6 SCIENTIFIC STOCK SPECULATION. 

stock market itself but in the country at large, 
in banking methods, in the promotion and sale 
of new securities, in the personnel of Wall Street 
and so on. 

In 1902 the railroad stocks were the principal 
part of the market. They were the favorites not 
only with investors but with speculators also. 
The U. S. Steel Corporation had been organized 
the previous year, the stock had been well dis- 
tributed to investors, and in 1904 it sold below 
$10 a share. Other industrials passed through 
a similar experience and were for the most part 
regarded questioningly. * 

This, it will be remembered, was before the 
heyday of Harriman. Even two years later, 
in 1904, Union Pacific sold at 71, and it was 
not until 1909 that its high price of 219 was 
reached. Only 4% dividends were paid on it in 
1902. 

The days of big speculation and wide price 
changes in industrial stocks had not then arrived. 
The few stocks which sold at very high prices 
were of an investment character and had an 
inactive market. The active speculation was in 
medium and low-priced issues. 

It is important to bear these differences in 
mind in order to get the full grasp of Mr. Dow's 
idea. If he were writing today, he would not 



SCIENTIFIC STOCK SPECULATION. 7 

make any essential changes in the principles laid 
down ; but he would probably modify some of 
his statements and would present a wider range 
of illustrations of the application of his methods 
to different classes of securities. 

I have not been willing to tamper with a text 
so clear, succint and well worded, but have added 
some notes, in order to call attention to some 
of the more important changes in conditions 
and market customs which have taken place since 
Mr. Dow wrote. 

There are many, of course, who will quarrel 
with the title of this book, "Scientific Stock 
Speculation/' on the ground that speculation can 
never be reduced to a science. It is true that it 
cannot be reduced to a mathematical science, but 
it is certainly entitled to be called a science in 
the same sense that economics is a science. 

Science in speculation must deal with tenden- 
cies rather than with exact mathematical conclu- 
sions. It is very noticeable that those who are 
most successful as investors for profit are usually 
of the type of the business man rather than the 
trained student of mathematics. The mathema- 
tician is always seeking some invariable rule 
or fundamental principle of fluctuations. This 
he cannot find. All speculative rules musl be 
approximate. Any rule may be upset by the sud- 



8 SCIENTIFIC STOCK SPECULATION. 

den development of new conditions. 

To take as an example the old problem of the 
man rowing a boat directly across a river in a 
high wind : The mathematician, if given the 
rower's rate of speed, the rate of flow of the 
river, and the effect of the wind on the boat, can 
resolve these forces and show how far down 
the river the landing will be at the other side. 

But to resolve the forces which control the 
price of a stock, a hundred different influences 
might have to be taken into account, some im- 
portant and some slight, all varying constantly in 
the amount of their effect, and with the ever- 
recurring possibility of some new force appear- 
ing which would be temporarily more powerful 
than all the others put together. 

Clearly this constitutes a problem beyond the 
reach of mathematics. Yet it is quite possible 
to estimate the importance of the principal ele- 
ments in the situation ; to make reasonable al- 
lowances for the possibility of some new factor 
entering in; to see in advance some of the 
changes which are impending; and to adjust the 
available capital to the character of the oppor- 
tunity by means of the principle of averaging in 
some form, so that results are obtained which 
may properly be called scientific in a correct 
sense of that word. 



SCIENTIFIC STOCK SPECULATION. U 

Mr. Dow brings out very clearly the two wavs 
in which the principle of averaging is employed 
in speculation : 

(i) By buying small lots of a stock at fixed 
price intervals as it declines, and 

(2) Taking small losses when wrong and cal- 
culating for a certain average of correctness; 
that is, for being right three times out of five, 
or four times out of seven. 

While the two plans are diametrically opposite 
in practice, both are based on the idea of averag- 
ing. It is probably safe to say that nine out of 
ten successful speculators make use of this prin- 
ciple of averaging in some form. 

The chapter on 'The Recurrence of Crises" 
is, of course, intended merely as a brief sketch 
of the subject. It is evident that Mr. Dow had 
not devoted much attention to the study of trade 
cycles. In fact, most of the progress in making 
practical use of the idea of cycles has been made 
since he wrote. 

Methods of trading which stand the test of 
twenty years without the necessity of any im- 
portant revision necessarily command respect, 
and it is probably not too much to say that 
no one should begin his stock market experience 



10 SCIENTIFIC STOCK SPECULATION. 

without having absorbed, from some source or 
other, the ideas which Mr. Dow presents so 
briefly and clearly in* this book. 



CHAPTER I. 
Scientific Speculation. 

THE question whether there is such a thing 
as scientific speculation is often asked. 
Various answers of a somewhat affirmative 
character have been given but they have gener- 
ally been hedged about with so many qualifica- 
tions as to be nearly useless for practical pur- 
poses. The experiences of operators have, how- 
ever, crystallized into some general rules worth 
heeding. -*. 

The maxim "buy cheap and sell dear" is as 
old as speculation itself, but it leaves unsolved 
the question of when a security or a commodity 
is cheap and when it is dear, and this is the 
vital point. 

The elder Rothschilds are said to have acted on 
the principle that it was well to buy a property 
of known value when others wanted to sell and 
to sell when others wanted to buy. There is a 
great deal of sound wisdom in this. The public, 
as a whole, buys at the wrong time and sells 
at the wrong time. The reason is that markets 

11 



12 SCIENTIFIC STOCK SPECULATION. 

are made in part by manipulation and the public 
buys on manipulated advances and after they are 
well along. Hence it buys at the time when 
manipulators wish to sell and sells when manipu- 
lators wish to buy. {See Note I.) 

Note 1. — It is probable that Mr. Dow had in mind 
the manipulation of a single stock or group of stocks, 
rather than of the market as a whole. The whole mar- 
ket taken together is too big to be successfully handled 
by any manipulator or group of manipulators. This, in 
fact, grows less and less possible every year as the 
numbers of securities and of' investors increase. 

On the other hand, it is naturally in times when the 
public becomes enthusiastic that various manipulators 
are busy in different issues, so that near the climax 
of a big bull market manipulation affects a larger num- 
ber of issues than at other times, and thus the general 
average of prices may be said to be partly dependent on 
manipulation. 

But the fact should be remembered that both the pub- 
lic enthusiasm and the manipulation which accompanies 
it are the results of the conditions which made the bull 
market possible. Instances of manipulation purely at 
the will of some individual or group, regardless of cur- 
rent or prospective changes in actual conditions affect- 
ing values, are becoming more rare year by year, since 
it becomes more and more difficult to make such manip- 
ulations profitable. 



SCIENTIFIC STOCK SPECULATION. 13 

In some commission offices, there are traders 
who, as a rule, go against whatever the outside 
customers of the house are doing. When mem- 
bers of the firm say, "all our customers are get- 
ting long of stocks/ 1 these traders sell out; but 
they buy when the firm says, "the customers are 
all short." There are, of course, exceptions to 
this rule. If there were no exceptions, the keep- 
ers of bucket shops w r ould all get rich. When 
the market has an extraordinary rise, the public 
makes money, in spite of beginning its purchases 
at what would ordinarily be the wrong time, 
and this is when the bucket shops either lose their 
money or close out in order to keep such money 
of customers as they have in hand. 

All this points to the soundness of the 
Rothschild principle of buying a property of 
known value when the public generally is dis- 
posed to sell ; or of selling it when the public 
thinks it a time to buy. 

Daniel Drew used to say, "cut your losses 
short, but let your profits run." This was good 
preaching, but "Uncle Dan" did not, in his later 
years, practice this rule, when it would have 
been better for him if he had. The thought here 
is unquestionably one of the sound principles in 
trading. It means that if a stock has been pur- 
chased and it goes up, it is well to wait; but if it 



14 SCIENTIFIC STOCK SPECULATION. 

goes down, it is well to stop the loss quickly on 
the ground that the theory on which the pur- 
chase was made was wrong. 

The public, as a whole, exactly reverses this 
rule. The average operator, when he sees two 
or three points profit, takes it ; but if a stock goes 
against him two or three points, he holds on wait- 
ing for the price to recover, with, oftentimes, 
the result of seeing a loss of two or three points 
run into a loss of ten points. He then becomes 
discouraged and sells out near the bottom to pro- 
tect the margin which he has left. 

How many operators in looking over their 
books find a considerable number of small profits 
swept away by one large loss? When a trader 
finds by his accounts that his profits have been 
relatively large and his losses relatively small, he 
can make up his mind that he is learning how 
to trade. 

The trouble with carrying out this plan i 
that a series of losses of from iy 2 to 2 points are 
very discouraging. A trader who sees that he 
has taken twice or three times a loss of two 
points when, if he had waited a few days he need 
not have taken any loss, is very apt to decide 
that he will not cut his losses short any more 
but will wait, and this is the time when the 
recovery does not come. 



SCIENTIFIC STOCK SPECULATION. I 5 

Mr. Jay Gould said his policy was to endeavor 
to foresee future conditions in a property and 
then, having made his commitments carefully, 
to exercise great patience in awaiting results. 
This also is sound doctrine, but proceeds along 
very different lines. Assuming the ability to fore- 
see the future, it is the wisest of all courses ; 
but many who have tried this method have found 
that the omission of essential factors made then- 
forecast valueless, and both their courage and 
their patience of little avail. Nevertheless, this 
method should not be discarded on account of 
the difficulties involved. Within limitations, the 
future can be foreseen. The present is always 
tending toward the future and there are always 
in existing conditions signals of danger or en- 
couragement for those who read with care. 



CHAPTER II. 

The Two General Methods of Trading. 

THERE are two general methods of trading. 
One is to deal in active stock in compara- 
tively large amounts, relying for protection 
upon stop orders. In this method of trading it is 
not necessary to know much about the values. 
The point of chief importance is that the stock 
should be active enough to permit the execution 
of the stop order at the point selected so as to cut 
ses short. The operator, by this method. 
guesses which way the stock will move. If he 
guesses right, he lets his profits run. If he 
wrong, he goes out on the stop order. If 
he can guess right as often as he can guess wrong 
he is fairly sure of profits. 

The other system is an entirely different prop- 
osition. It starts with the assumption that the 
operator knows approximately the value of the 
stock in which he proposes to deal. It assumes 
that he has considered the tendency of the gen- 
eral market ; that he realizes whether the stock 
in which he proposes to deal is relatively up or 

17 



l8 SCIENTIFIC STOCK SPECULATION. 

down, and that he feels sure of its value for at 
least months to come. 

Suppose this to exist: The operator lays out 
his plan of campaign on the theory that he will 
buy his first lot of stock at what he considers the 
right price and the right time, and will then buy 
an equal amount every i per cent, down as far 
as the decline may go. 

This method of trading is the one generally 
employed by large operators. They know the 
value of the stock in which they propose to deal, 
and are therefore reasonably secure in following 
a decline. They feel about a stock as merchants 
feel about buying staple goods. If an article 
is cheap at $100, they know it is cheaper at $90, 
and will strain a point to buy at $80 or at $70, 
knowing that the price must recover. This is the 
way a large operator looks at his favorite stocks 
and this is why he generally makes money in 
them. 

The disadvantage of the small operator in fol- 
lowing this method is two-fold. He does not 
absolutely know the value of the stock. That 
is, he may know the truth up to a certain point, 
but beyond that is an unknown factor which in- 
terferes with the result. When the price of a 
stock declines considerably, the small operator 
always fears that he has overlooked something 



SCIENTIFIC STOCK SPECULATION. IQ 

of importance, and he is therefore tempted to sell 
instead of averaging his holdings. 

The second disadvantage of the small operator 
in following this policy is that he seldom pro- 
vides sufficient capital for his requirements. 
Thousands of speculators believe that because 10 
per cent, is a common speculative margin, $1,000 
justifies them in trading in hundred share lots. 
This impression produces losses continually. 

The man who has $1,000 for speculation is not 
well equipped for trading in even 10 share lots, 
if he proposes to deal on a scale. A comparison 
of high and low prices of active stocks shows 
frequently a difference of 30 points in a year. 
Any operator proposing to follow a stock down, 
buying on a scale, should make his preparations 
for a possible fall of from 20 to 30 points. As- 
suming that he does not begin to buy until his 
stock is 5 points down from the top, there is still 
a possibility of having to buy 20 lots before the 
turn will come. 

If, however, an outsider will provide $2,500, 
as his speculative capital and will trade in ten- 
share lots in a thoroughly good railroad stock, 
beginning his purchases only after a decline of 
five points in a rising market, and ten points in 
a bear market, following the decline with pur- 
cha>es every point down, and retaining all the 



20 SCIENTIFIC STOCK SPECULATION. 

stock bought, he seldom need make a loss. (See 
Note 2.) 

Such campaigns require time, patience, and 
the pursuance of a fixed policy, but whoever will 
follow this policy will find himself able to get 
a high rate of interest on the capital invested. 

1/ It is an old saying in Wall Street that the man 
- who begins to speculate in stocks with the in- 
tention of making a fortune, usually goes broke, 
whereas the man who trades with a view of 
getting good interest on his money, sometimes 

A gets rich. 

This is only another way of saying that money 
is made by conservative trading rather than by 
the effort to get large profits by taking large 

* risks. After allowing for all the risks involved, 
we think the outsider who wants to trade in 

Note 2. — There has been a great change in the 
character of the market since these paragraphs were 
written. What Mr. Dow said is still true of a large 
number of low and medium priced stocks which have 
sound investment value behind them. But many other 
issues, selling at a higher price or having a more specu- 
lative character, now have much wider fluctuations 
than those here mentioned and would require a cor- 
respondingly larger capital in proportion to the number 
of shares bought. 



SCIENTIFIC STOCK SPECULATION. 21 

stocks has a better chance working in small lots 
on a scale than in any other way, provided he 
will pay attention to certain essential points, 
which for convenience of reference we will enu- 
merate in order. 

i. — Bull markets and bear markets run four 
and five years at a time. Determine by the 
average prices, which one is under way. (See 
Note 

2. — Determine the stock or stocks to trade in. 
They should be railroad stocks, dividend payers, 
not too low, nor too high, fairly active, and for 
the bull side below their value; for the bear side 
above their value. Values are determined rough- 
lv bv the earnings available for dividends. (See 
te. 4.) 

3. Observe the position of your stock with re- 
lation to recent fluctuations. In a bull market, 

re 3. — In recent years the average duration of bull 
and bear markets has been shorter than here indicated. 
"Tidal Swings of the Stock Market," by Scribner 
Browne, published bv The Magazine of Wall Street. 

TE 4. — At the time this was written the industrial 
issues were comparatively new and were regarded as 
more speculative than the rails. Industrial stocks suited 
to this purpose could now be ^elected. 



22 SCIENTIFIC STOCK SPECULATION. 

the time to begin to buy is when a stock has had 
four or five points decline from the last previous 
top. In a bear market, the time to begin to sell 
is when such a stock has had three or four points 
rally from the bottom. 

4. — Stick to the stock bought until a fair profit 
or until there is good reason for deciding that 
the first estimate of value was wrong. Remem- 
ber that an active stock will generally rally from 
three-eighths to five-eighths of the amount of its 
decline under adverse conditions and more than 
that under favorable conditions. 

5. — Have money enough to see a decline 
through without becoming uneasy or over-bur- 
dened ; $2,500 ought to take care of a ten-share 
scale every point down — that is to say, suppos- 
ing the first lot to be bought five points down 
from the top, $2,500 ought to carry the scale 
until the natural recovery from the low point 
brings the lot out with a profit on the average 
cost. It will not do to expect a profit on every 
lot, but only on the average. In a bull market 
it is better to always work on the bull side; in 
a bear market, on the bear side. There are usu- 
ally more rallies in a bear market than there are 
relapses in a bull market. {See Note 5.) 

Note 5. — As affecting more recent markets, this state- 
ment seems open to question. 



S< tENTIFIC STOCK SPECULATION. 23 

6. — Do not let success in making money in ten- 
share lots create a belief that a bolder policy will 
be wiser and begin to trade in 100-share lots 
with inadequate capital. A few hundred-share 
losses will wipe out a good many ten-share 
profits. 

7. — There is not usually much difficulty in 
dealing in ten-share lots on the short side. If 
one broker does not wish to do it, another prob- 
ably will, especially for a customer who amply 
protects his account and who seems to under- 
stand what he is doing. 



CHAPTER III. 
Thrfe General Lines of Reasoning. 

WE have spoken in a preceding article of 
the fact that the experience of great in- 
terests in the market seems to have crvs- 
talized into three general lines of reasoning. 

The first is that the surface appearance of the 
market is apt to be deceptive. The second is 
that it is well in trading to cut losses short and 
let profits run. The third is that correctly dis- 
counting the future is a sure and easy road to 
wealth. The problem is how these rules which 
are undoubtedly sound, can be operated in a prac- 
tical way. 

Let us take first the action of the general mar- 
ket with reference to the time to buy. The mar- 
ket is always to be considered as having three 
movements, all going on at the same time. The 
first is the narrow movement from day to day. 
The second is the short swing, running from 
two weeks to a month or more; the third is the 
main movement covering at least four years in 
it- duration. (See Xote 3, p. 21.) 

25 



26 SCIENTIFIC STOCK SPECULATION. 

The day to day movement should be disre- 
garded by everybody, except traders who pay 
no commissions. The medium swing is the one 
for ordinary consideration. The outside trader 
should not attempt to deal in more than two or 
three stocks at a time. He should keep a chart 
of the price movements of these stocks so as to 
know their swings for months or years, and thus 
be able to tell readily where in the general swing 
his particular stocks appear to be. 

He should keep with his price movement a 
record of the volume of transactions and notes 
of any special facts bearing on that property, 
such as increases or decreases in earnings, in- 
creases in fixed charges, development of floating 
debt, and above all the actual earnings available 
for dividends as shown from month to month. 
He should observe the movement of the general 
market as indicated by the average published 
daily, as this shows the market more clearly 
than it is shown by any one stock. {See Note 

6.) . 

The main purpose of this study is to enable 

the trader to determine, first, the value of the 

Note 6. — Daily averages of the market are now pub- 
lished by various newspapers. Among the best are 
those of the New York Times and the Wall Street 
Journal. 



SCIENTIFIC STOCK SPECULATION. 2J 

stock he is in ; whether it is increasing or de- 
creasing and, second, when the time to buy 
seems opportune. Assuming the thirty day swing 
to be about five points, it is in the highest de- 
gree desirable not to buy when three of these 
points have passed, as such a purchase limits 
the probable profit to about two points. 

It is therefore generally wise to look for a low 
point on a decline. Suppose, for instance, that 
Union Pacific was the stock under consideration; 
that it was clearly selling below its value, and 
that a bull market for the four-year period was 
under way. Assuming further that in a period 
of reaction Union Pacific had fallen four points 
from the previous highest. Assume earnings and 
prospects to be favorable and the outlook for 
the general market to be about normal. (See 
Xote 7.) 

This would be the time to begin to buy Union 
Pacific. The prudent trader, how r ever, would 
take only part of his line. He would buy perhaps 
one-half of the stock he wanted and then give 
an order to buy the remainder as the price de- 
clined. The fall might go much further than 
he anticipated. It might be necessary to wait 

Mote 7. — Written, of course, before the excited 
fluctuations of Union Pacific, under the Harriman 
me. 



28 SCIENTIFIC STOCK SPECULATION. 

a long time for profit. There might even be 
developments which would make it wise to throw 
over the stock bought with the hope of replacing 
it materially lower. 

These, however, are all exception**. In a ma- 
jority of cases this method of choosing the time 
to buy, founded upon clear perception of value 
in the stock chosen and close observation of the 
market swings under way will enable an operator 
to secure stock at a time and at a price which 
'will give fair profits on the investment. 



CHAPTER IV. 

Swings Within Swings. 

A CORRESPONDENT asks: "For some 
time you have been writing rather bullish 
on the immediate market, yet a little bear- 
ish in a larger sense. How do you make this 
consistent?" 

We get this question in one form or another 
rather frequently. It denotes a lack of famili- 
arity with fluctuations in prices when viewed 
over considerable periods. Many people seem 
to think that the change in prices in any one 
day is complete in itself and bears no relation 
to larger movements which may be under way. 
This is not so. 

Nothing is more certain than that the market 
has three well defined movements which fit into 
each other. The first is the daily variation due 
to local causes and the balance of buying or sell- 
ing at that particular time. The secondary 
movement covers a period ranging from ten days 
to sixty days, averaging probably between thirty 
and forty days. The third move is the great 
swing covering from four to six years. 

29 



30 SCIENTIFIC STOCK SPECULATION. 

In thinking about the market, it is necessary 
to think with reference to each of these periods 
in order to take advantage of opportunities. If 
the main move is up, relapses are speculators' 
opportunities, but if the main move is down, ral- 
lies furnish these opportunities. 

Losses should not generally be taken on the 
long side in a bull period. Nor should they gen- 
erally be taken on the short side in a bear period. 
It is a bull period as long as the average of one 
high point exceeds that of previous high points. 
It is a bear period when the low point becomes 
lower than the previous low points. It is often 
difficult to judge whether the end of an ad- 
vance has come because the movement of prices 
is that which would occur if the main tendency 
had changed. Yet, it may only be an unusually 
pronounced secondary movement. 

The first thing for any operator to consider is 
the value of the stock in which he proposes to 
trade. The second is to determine the direction 
of the main movement of prices. We know of 
nothing more instructive on this point than the 
course of prices as printed daily. The third 
thing is to determine the position of the sec- 
ondary swing. 

Assume for instance that the stock selected 
was Union Pacific; that the course of prices 



SCIENTIFIC STOCK SIUXl'LATION. 31 

afforded clear evidence of a bull market under 
way ; that the high point in Union Pacific thirty 
days ago was 10S; that the price had slowly de- 
clined in sympathy with the market and without 
special new features to 98. The chances would 
he in favor of buying a part of the line wanted 
at that price with the intention of buying a little 
more if the stock had further decline or if the 
price showed a well defined advancing tendency. 
It would then be wise to watch the general mar- 
ket and wait for an advance. 

A 10-point decline under such conditions 
would be almost certain to bring, in a bull mar- 
ket, more than five points recovery and full ten 
points would not be unreasonable ; hence if the 
general market maintained a good tone, it w r ould 
be wise to wait for five points and then begin 
to think about stop orders. 

Even in a bear market, this method of trad- 
ing will be usually be found safe, although the 
profit taken should be less because of the liability 
of weak spots breaking out and checking the 
general rise. 



CHAPTER V. 
Methods of Reading the Market. 

A CORRESPONDENT writes: "Is there 
any way of forecasting the course of the 
market from the tape, from your records 
of transactions or from the summarized move- 
ment of prices? Transactions must mean some- 
thing, but how can a trader tell what they mean?" 
This is an old question. There have been 
a variety of answers but it is doubtful if any 
have been or can be wholly satisfactory. Sev- 
eral methods, however, are in practical use and 
at times afford suggestions. 

There is what is called the book method. 
Prices are set down, giving each change of one 
point as it occurs, forming thereby lines having 
reneral horizontal direction but running into 
diagonals as the market moves up and down. 
There come times when a stock with a good de- 
gree of activity will stay within a narrow range 
of prices, say two points, until there has formed 
quite a long horizontal line of these figures. The 
formation of such a line sometimes suggests that 
k has been accumulated or distributed, and 
33 



34 SCIENTIFIC STOCK SPECULATION. 

this leads other people to buy or sell at the 
same time. Records of this kind kept for the 
last fifteen years seem to support the theory that 
the manipulation necessary to acquire stock is 
oftentimes detected in this way. 

Another method is what is called the theory 
of double tops. Records of trading show that 
in many cases when a stock reaches top it will 
have a moderate decline and then go back again 
to near the highest figures. If after such a move, 
the price again recedes, it is liable to decline some 
distance. 

Those, however, who attempt to trade on this 
theory alone find a good many exceptions and a 
good many times when signals ar8 not given. 

There are those who trade on the theory of 
averages. It is true that in a considerable period 
of time the market has about as many days of 
advance as it has of decline. If there comes 
a series of days of advance, there will almost 
surely come the balancing days of decline. 

The trouble with this system is that the 
small swings are always part of the larger swings, 
and while the tendency of events equally liable 
to happen is always toward equality, it is also 
true that every combination possible is liable to 
occur, and there frequently come long swings, or, 
in the case of stock trading, an extraordinary 



SCIENTIFIC STOCK SPECULATION. 35 

number of days of advance or decline which 
fit properly into the theory when regarded on 
a long scale, but which are calculated to upset 
any operations based on the expectation of a se- 
ries of short swings. 

A much more practicable theory is that found- 
ed on the law of action and reaction. It seems 
to be a fact that a primary movement in the 
market will generally have a secondary move- 
ment in the opposite direction of at least three- 
eighths of the primary movement. If a stock 
advances ten points, it is very likely to have a 
relapse of four points or more. The law seems 
to hold good no matter how far the advance 
goes. A rise of twenty points will not infre- 
quently bring a decline of eight points or more. 

It is impossible to tell in advance the length of 
any primary movement, but the further it goes, 
the greater the reaction when it comes, hence the 
more certainty of being able to trade successfully 
on that reaction. 

A method employed by some operators of large 
experience is that of responses. The theory in- 
volved is this : The market is always under more 
or less manipulation. A large operator who is 
seeking to advance the market does not buy 
even-thing on the list, but puts up two or three 
leading stocks either by legitimate buying or by 



36 SCIENTIFIC STOCK SPECULATION. 

manipulation. {See Note 8.) He then watches 
the effect on the other stocks. If sentiment is 
bullish, and people are disposed to take hold, 
those who see this rise in two or three stocks 
immediately begin to buy other stocks and the 
market rises to a higher level. This is the public 
response, and is an indication that the leading 
stocks will be given another lift and that the 
general market w T ill follow. 

If, however, leading stocks are advanced and 
others do not follow, it is evidence that the public 

Note 8. — When this was written it was possible for 
a large operator to advance quotations by bidding for 
larger Jots than were offered; that is, he could bid 
for 5,000 shares, all or none. This is perhaps the 
species of manipulation here referred to. Under the 
present rules of the Stock Exchange this cannot be 
done, since the bidder must accept any part (in hundred 
share lots) of the amount bid for. 

A certain amount of manipulation is still possible by 
purchasing heavily of a certain stock in a very short 
time, regardless of what price has to be paid. In that 
way only the "resting" orders will be encountered, since 
other traders do not have time to put in new selling 
orders until after the move is over, and the quickness 
of the rise may discourage them from putting in selling 
orders at all. 



SCIENTIFIC STOCK SPECULATION. 37 

is not disposed to buy. As soon as this is clear 
the attempt to advance prices is generally dis- 
continued. This method is employed more par- 
ticularly by those who watch the tape. But it can 
be read at the close of the day in the record of 
transactions* by seeing what stocks were put up 
within specified hours and whether the general 
market followed or not. 

The best way of reading the market is to read 
from the standpoint of values. The market is 
not like a balloon plunging hither and thither in 
the wind. As a whole, it represents a serious, 
well considered effort on the part of far-sighted 
and well-informed men to adjust prices to such 
values as exist or which are expected to exist 
in the not too remote future. The thought with 
great operators is not whether a price can be 
advanced, but whether the value of property 
which they propose to buy will lead investors 
and speculators six months hence to take stock 
at figures ten to twenty points above present 
prices. 

In reading the market, therefore, the main 
point is to discover what a stock can be expected 
to be worth three months hence and then to see 
whether manipulators or investors are advancing 



*Wal1 Street Journal, or official Stock Exchange lists. 



38 Scientific stock spec:ulatioM. 

the price of that stock toward those figures. It 
is often possible to read movements in the mar- 
ket very clearly in this way. To know values 
is to comprehend the meaning of movements in 
the market. 






CHAPTER VI. 
The Operation of Stop Orders. 

A CORRESPONDENT inquires : "My 
brokers advise me to protect my transac- 
tions by stop orders. It seems to me that 
stop orders may be good for brokers by giving 
them commissions, but they make customers 
take unnecessary losses. Do you advise specu- 
lators to give stop orders ?" 

Proof on this point is afforded by taking a 
large number of fluctuations and seeing how the 
average works out. We believe that for the mar- 
gin trader, and especially the trader who operates 
rather more largely than he ought on the margin 
that he has, stop orders are wise. There are, 
however, many qualifications which should be 
kept in mind. 

If a man is trading as a semi-investor, using 
fifty per cent, margin, depending on values for 
his profit and operating in harmony with the 
main tendency of the market, we do not think 
a stop order desirable. To explain this a little 
more fully : Suppose the movement of averages 
shows that the market is in a rising period, such 
periods usually covering several years with only 

39 



40 SCIENTIFIC STOCK SPECULATION. 

temporary reversals in direction. Suppose that 
an operator finds that a certain stock is earning 
an abnormal percentage on its market value, or, 
in other words, is intrinsically cheap. Suppose 
on the occasion of a temporary setback this stock 
is bought to be carried for months if necessary 
until the price has risen to approximately the 
level of the value. A stop order is folly in a case 
of this kind with anything like fair margin. 

But, suppose a trader, having a margin of two 
or three thousand dollars, wants to trade in and 
out of stocks without regard to values, but be- 
ing governed by points or by impressions of what 
the general market is going to do. Experience 
has shown that such a trader will, in the end, 
profit by putting a stop order about two points 
from the price at which he goes in. If there is 
advice that a stock is going tip and it instead goes 
down two points without some obviously good 
reason for such a decline, the advice was not 
good, and the quicker the speculator lets go the 
better. 

It often happens that when a stock moves two 
points it moves more, and it is a peculiarity of the 
human mind to disregard a small loss, but to get 
frightened and take a large loss just when wis- 
dom would call for averaging a purchase. 

Thousands of traders have said at two points 



SCIENTIFIC STOCK SPECULATION. 4I 

loss that they would see that particular transac- 
tion through if the stock went to nothing, only 
to decide after it had declined ten points that 
there was good reason for believing that it would 
decline ten more and acting accordingly. The 
experience of most traders is that the small losses 
occasioned by stop orders have a tendency to 
check their trading with a small aggregate loss, 
while the practice of letting a loss run not infre- 
quently makes a loss so large that trading comes 
to an end because the speculator has no more 
money. 

The maxim "let your profits run, but cut your 
losses short" has received the approval of most 
of the great stock operators. The authorship 
of the maxim has been credited to a dozen people, 
and most of them would have been willing to 
father it, although the great fortunes in stocks 
have not usually been made by people w r ho give 
stop orders. Their opinion that stop orders were 
wise was based on their observation of people 
who tried to trade with insufficient capital, to 
whom stop orders especially apply. 

The great profits in stocks have almost in- 
variably been made by people who saw the ten- 
dency of events clearly and who then bought a 
large amount of stock which they thought cer- 
tain to get the results of great increase in pros- 



42 SCIENTIFIC STOCK SPECULATION. 

perity. Such stock has either been paid for out- 
right or very heavily margined, and then it has 
been held for months or years until great profits 
accrued. 

Take the opportunities that have occurred in 
the last six years, or since 1896. Any one of 
from twenty to forty stocks could have been 
bought around 20 and sold above 80, and in at 
least half the cases above par, within that time. 
Such great opportunities do not come every year, 
but there are few times when some stocks can- 
not be pointed out as being lower in price than 
in value and as entitled to advance. 

In a close speculative sense, a stop order is 
often useful. Stocks may be bought just when 
a reaction is setting in. In this case, it is fre- 
quently wise to take a quick loss on the theory 
that the reaction is likely to be five or six points, 
and that the stock can be recovered with a net 
saving of two or three points. A stop order is 
of no use to out-of town traders, because some- 
times the market moves a good deal before a 
broker can communicate with his client and get 
an order to act. Stop orders are often valuable 
on the short side of the market, because a scare 
of shorts after considerable decline sometimes 
brings a very rapid rise, which runs away with 
all the profits that have accrued. 



SCIENTIFIC STOCK SPECULATION. 43 

Customers who give stop orders should, how- 
ever, understand exactly what they mean. A 
customer who, being long of Union Pacific at 
105, should give an order to stop at 103, would in 
effect be saying to the broker: "Whenever Union 
Pacific sells at 103, sell my stock immediately 
at the best price obtainable. " 

If the best price obtainable' were 102 or even 
101, the broker would still be within his rights 
in executing the order. Hence, in giving stop 
orders, thought should be taken as to the size 
of the market in the stock. In Union Pacific, for 
instance, a stop order ought to be executed within 
V& or ^4 P er cent, of the stop order price, ex- 
cept in cases of panic, but a stop order in Lack- 
awanna or Chicago & Eastern Illinois or in some 
industrial stock would be very dangerous, be- 
cause no approximate idea could be formed as to 
what price would have to be accepted. (See 
Note 4, p. 21.) 

Stop orders should not be given in any case 
in stocks of very limited market. In other 
stocks, their value will be found to depend large- 
lv upon the methods emploved bv the trader him- 
self. 



CHAPTER VII. 

Cutting Losses Short. 

WE have spoken in previous articles of meth- 
ods of trading. Experience proves that 
every operator should adopt one of two 
methods : Either cut losses short, or take an in- 
vestment position. We propose to point out today 
some of the advantages of cutting losses short. 

The buyer of any stock has some reason for 
his action. He has heard that the stock is going 
up ; he believes that it is selling below its value, 
he sees that a bull market is under way and be- 
lieves that this stock will go up as much as any 
other. These and similar reasons lead to buying. 
It is obvious that in all but one of these cases 
the buyer does not profess to know anything 
definitely about the stock he buys. He acts on 
the suggestions or advice of others. Points are 
good when they are good, and under some con- 
ditions can very wisely be followed. There is 
nothing better in trading than to know that a 
great operator or a great syndicate intends for 
good reasons to move the price of a stock from 
a lower to a higher figure. 

45 



46 SCIENTIFIC STOCK SPECULATION. 

But almost everybody learns by sad experi- 
ence that the "best laid plans of mice and men 
gang aft agley." Great operators change their 
minds about the expediency of market move- 
ments and most of them have learned that it is 
one thing to will and another to do in stock spec- 
ulation. Hence the trader who takes a point, 
even from good sources, has only partial assur- 
ance of profitable results. 

His true protection in such a case lies in a 
stop order. If the price advances, well and good, 
but if it declines his stop order cuts his loss 
short, while those who do not stop the loss, but 
who listen to assurances that the market is all 
right, often see larger losses in the end. 

The general rule is to stop losses within a 
range of two or three points from the purchase 
price. All purchases on points, tendencies and 
rumors should be regarded as gpesses and pro- 
tected by stop orders. Traders, looking oyer their 
accounts, seldom lament the losses of $200, which 
they find scattered through their books as the 
result of stops, but they deeply lament the $1,500 
or the $2,500 losses which reflect over-confidence 
in a position which proved unsound. 

The difficulty with stop orders is that they 
are frequently exercised when the event shows 
that the loss need not have been taken. There is 



SCIENTIFIC STOCK SPECULATION. 47 

no help for this, but the placing of a stop order 
can be wisely varied by the circumstances of a 
given case. Suppose, for instance, that the five- 
year movement showed a bull market to be in 
progress ; that there has come in this advance a 
five-point reaction in a stock like Union Pacific 
and that a purchase had been made five points 
from the previous highest. 

If the price declined two points more in such 
a case, it would probably be wise to exercise 
the stop order as the fall would suggest a down 
swing of larger proportions than had been an- 
ticipated. It might be such a move as occured 
in December, 1899, when stop orders proved 
exceedingly profitable in bull accounts. If the 
price subsequently recovered the two points, and 
the stock was repurchased at about the original 
price, it would probably be wise to put the stop 
order the next time about three points away, 
under a belief that the stock would not go quite 
so low as it went before and that the stop order 
would therefore not be executed. 

If this reasoning proved sound, and the price 
advanced the stop order could wisely be kept 
three points below the market price until the 
stock had advanced several points and showed 
signs of what is called "toppiness." Then it 
might be well to advance the stop order to two 
points and await developments. 



48 SCIENTIFIC STOCK SPECULATION. 

The stop order is of primary importance when 
a purchase is first made and when its wisdom 
is in doubt. It is also of primary importance in 
pyramiding; that is, where stock is being bought 
on an advancing market every point up, because 
in such a case the stop order is relied upon to 
prevent the turning of a profit into a loss. It is 
of importance when a stock has had its normal 
swing for the purpose of saving most of the profit 
if a reaction comes, while leaving a chance open 
for further advance. It is of least importance 
when a stock has been well bought and is slowly 
advancing. It should be set further away from 
the market at such a time than any other so as 
to avoid being caught on the small setbacks 
which occur in an advancing period. 

By means of a stop order, an operator can 
trade freely in active stocks of uncertain value, 
which he would not venture to touch as an in- 
vestment. By it, he can trade in much larger 
amounts than he could otherwise undertake to 
protect. The stop order is the friend of the 
active speculator, who wants to make a quick 
dash for a large profit and who is willing to 
make small losses in the hope of getting a good 
run once in four or five attempts. It is the 
friend of the small operator, the out-of-town 
operator and the timid operator. It should be 



SCIENTIFIC STOCK SPECULATION. 49 

applied, however, only in active stocks where 
there is a large market. Stop orders should 
not be given in inactive stocks, as the seller may 
be slaughtered in their execution. 

A stop order to sell 100 shares of Union Pacific 
at 75 means that the stock must be sold at the 
best price obtainable as soon as there has been a 
transaction at 75. If the best price w r ere 74 or 
J2» it would still be the duty of the broker to sell. 
Hence the importance of not giving such orders 
in stocks where wide differences in quotations 
may be expected. 









CHAPTER VIII. 
The Danger in Overtrading. 

A FREQUENT inquiry is: "Can I trade in 
stocks on a capital of $100, buying on a 
scale up and stopping my loss so as to pro- 
tect my original capital?" 

There are a great many people in the United 
States who think about trading in stocks on a 
capital of Sioo or $200. Many of them believe 
that if a thousand dollars is a proper 10 per 
cent, margin for trading in 100 shares, $100 must 
be a fair margin for trading in 10 shares. We 
regard this reasoning as sound, but dissent from 
the conclusion that $1,000 justifies trading in 100 
share lots. 

The reason is that nobody can hope to buy at 
the bottom or to sell at the top ; or to be right all 
the time or to avoid losses. Making money in 
-u>ck- for most people resolves itself into a 
series of transactions in which we may say there 
are six profits and four losses, resulting in a net 
gain. The experience of good traders shows that 
the operating expenses in trading, that is to saw 

51 



52 SCIENTIFIC STOCK SPECULATION. 

the ratio of losses to profits, run from 50 to 65 
per cent, of the total profits. 

A man who may have made $10,000 gross 
in trading in a specified time will be very likely 
to have lost from $5,000 to $6,000 gross in the 
same time, leaving a net profit of from $4,000 to 
$5,000. Profits and losses run in streaks. There 
will be times of all profit and no loss, and times 
of all loss and no profit. But the average even 
for those who have learned to trade in stocks and 
who have abundant capital for their operations 
works out less than half of the gross profits as 
net profits. 

What chance is there for 10 per cent, to carry 
a speculator and especially a beginner through 
the losses which are almost certain to come be- 
fore he can accumulate any substantial profit? 
It is possible to say that if an operator had done 
this or that, buying at the right time and selling 
at the right time, 10 per cent, would have been 
ample. But, there is a great difference between 
seeing what might have been done in the past 
and undertaking to do something for the future. 

The man who wishes to trade in stocks and 
who has only $100 to lose, should, in our opinion, 
adopt one of two courses. He should buy out- 
right one share of some stock below par and 
below its value and wait until the advance in that 



SCIENTIFIC STOCK SPECULATION. S3 

stock to its value gives him a profit of 5 to 10 
per cent, as the case may be. This is probably 
the surest way. 

The other way is to buy two or three shares 
on margin, protecting the account by a stop 
order at about two points from the purchase 
price. Brokers generally are not anxious to take 
such small lots, but if a broker believes that a 
customer is trading on right lines, and is likely 
to make money, he will go out of his way con- 
siderably to serve that customer, under a belief 
that he will be worth something in the future. 
Nine brokers out of ten would say that an at- 
tempt to trade in stocks on a capital of $100 
was absurd. But, it would not be absurd if the 
trading basis were made two shares, as that 
would give the trader time in which to recover 
from his losses as well as some confidence in 
acting at the proper time and would be a sort 
of school in which experience could be gained. 

We think exactly the same reasoning holds 
good with regard to trading in 100-share lots 
on a basis of Si, 000. Some brokers accept such 
orders readily enough, but it is none the less 
over-trading, and none the less likely to result 
in the loss of the trader's capital. The man 
who buys 100 shares on a 10 per cent, margin 
and stops his loss at two points, has lost nearly 



54 SCIENTIFIC STOCK SPECULATION. 

one-quarter of his capital. He tries again and 
perhaps makes one point net. His third venture 
results in a loss of three points more and in a 
nearly total loss of confidence, leading him prob- 
ably to sell short just when he ought to have 
averaged, thereby completing the sacrifice of his 
money. 

If the same man with a capital of $1,000 had 
begun with 10 shares he could have stood his 
loss; he would have had courage to average or 
to buy something else at a low point and would 
very likely come out ahead. 

Almost any man can show profits in a stock 
by assuming that he would do so and so at 
various conditions of the market. He succeeds 
theoretically in this way because there is noth- 
ing at risk and his judgment is clear. The mo- 
ment, however, that he has a risk which is very 
large in proportion to his capital, he consults 
his fears instead of his judgment, and does in 
practice exactly opposite what he would have 
done had his transactions been purely academic. 

The remedy for this is to keep transactions 
down to a point, as compared with capital, which 
leaves the judgment clear and affords ample 
ability to cut loss after loss short; to double 
up; to take hold of something else, and generally 
to act easily and fearlessly instead of under the 



SCIENTIFIC STOCK SPECULATION. 55 

constraint which inevitably comes from a knowl- 
edge that the margin of safety is so small as to 
leave no room for anything except a few anxious 
gasps before the account is closed. 

If people with either large or small capital 
would look upon trading in stocks as an attempt 
to get 12 per cent, per annum on their money 
instead of 50 per cent, weekly, they would come 
out a good deal better in the long run. Every- 
body knows this in its application to his private 
business, but the man who is prudent and careful 
in carrying on a store, a factory or a real estate 
business seems to think that totally different 
methods should be employed in dealing in stocks. 
Nothing is further from the truth. 



CHAPTER IX. 
Methods of Trading. 

A CORRESPONDENT inquires : "How 
can a man living at a distance from Wall 
Street hope to follow the market closely 
enough to make any money trading in stocks:" 

This question comes to us in different forms 
frequently, and shows misapprehensions as to 
what is involved in successful trading. Many 
people seem to think that if an operator is in Wall 
Street, he can tell what the market is going to 
do. Nothing is further from the fact. The 
more a man really knows about speculation, the 
less certain he becomes in regard to any market 
movement, except as the result of general condi- 
tions. 

The distinction to be made between trading 
in the Street and trading from out of town is 
clear in one point. The operator who watches the 
ticker or blackboard can turn at very short notice, 
but the ability to turn quickly often proves a 
great disadvantage, because it leads to many 
turns at the wrong time. 

The out-of-town speculator should not attempt 
57 



58 SCIENTIFIC STOCK SPECULATION. 

to make quick turns, unless by private wire con- 
nections he is able to watch the market as a mat- 
ter of business. The out-of-town operator should 
trade on broad lines and from an investment 
standpoint. He should deal not in stocks that 
happen to be active, and not on points but al- 
most wholly on well considered convictions as 
to the probable course of the general market and 
the relative position of price to value of the 
special stocks in which he proposes to deal. 

The first question to consider is what consti- 
tutes a speculative investment. We should say 
it meant in most cases a railway stock paying 
regular dividends, publishing earnings, gross and 
net, at regular intervals and giving full particu- 
lars of its financial and physical condition as 
often at least as once a year. If oftener, so much 
the better. {See Note 4, p. 21.) 

It is possible to derive fairly accurate knowl- 
edge of the value of such a stock. It should be 
considered essentially with reference to its ability 
to maintain or increase its dividends. If the 
stock seems likely to continue a current rate of 
dividend, and the return on the cost is such as to 
make it fairly satisfactory as an investment, it is 
a good stock to buy when, in sympathy with de- 
cline in the general market, it has fallen below its 
normal price. 



SCIENTIFIC STOCK SPECULATION. 59 

Take, for instance, Union Pacific common. A 
few months ago this stock was selling between 
50 and 60. It was paying 4 per cent, dividends, 
and the company was known to be earning over 
8 per cent. Here was the case of a stock obvious- 
ly selling below its value. It has since risen more 
than 30 points. There were other stocks, per- 
haps not as cheap in point of value, but of which 
much that was favorable could be said. Three 
months ago the values of railway stocks generally 
were above their prices. 

Now, this can be said of very few stocks, and 
this fact ought to make an outsider slow to buy. 
The chances are that there will come, as there 
seems to be coming, declines which will carry 
prices back to a level where it will again be 
prudent to buy. Suppose that time to arrive. 
The wise course for an outsider will be to buy 
of a good railroad stock, an amount he can easily 
purchase outright, and which he would be will- 
ing to hold as an investment in case the price 
should decline. Should it then decline consider- 
ably it would probably be prudent for him to buy 
more lowering his average, but only after careful 
revision of the facts bearing upon the value and 
upon the general market. 

This stock should be held without regard to 
current fluctuations, until it showed a satisfac- 



6o scientific stock speculation. 

tory profit. Then it should be sold and the opera- 
tor should wait weeks or months if necessary for 
an opportunity to take it or some other stock 
back upon favorable terms. 

The outsider who tries to follow the market 
from day to day, is not likely to have very 
marked success. The operator who selects in- 
vestment properties carefully and buys after the 
market has had general declines, and who exer- 
cises a good deal of patience both in waiting for 
th6 time to buy and for the time to sell — who, in 
short, treats his speculation as an investment, will 
be likely to make money in stocks as a rule. 

A correspondent writes: "Is there any way 
by which an outsider who cannot watch fluctua- 
tions of the market hourly can trade in stocks 
with a fair chance of making money ?" 

We think there are two methods by either of 
which an outsider has a fair speculative chance. 
The first is to buy stocks for investment ; that is, 
to pay for them outright when they are selling 
below value and wait until they are up to value, 
getting the difference for a profit. 

Value is determined by the margin of safety 
over dividends, the size and tendency of earn- 
ings; the soundness of the balance sheet and of 
operating methods, and general prospects for the 
future. This sounds rather complicated, but is 
not especially difficult to work out. 



■ , 



SCIENTIFIC STOCK SPECULATION. 6l 

For instance, a year ago we almost daily 
pointed out that earnings had greatly increased 
during the year past ; that fixed charges had not 
increased, hence that the actual value of stocks 
had advanced while prices had in most cases de- 
clined. It was obvious that this could not last; 
that net earnings must decrease or prices ad- 
vance. There were then many stocks cheap on 
their earnings and this was easily a matter of 
demonstration. 

In the same sense it can now (1902) be said 
that most stocks are dear on their earnings. It 
is true that earnings have increased somewhat 
over last year, but prices of many stocks have 
advanced from 50 to 100 per cent., and in what- 
ever form the yardstick is applied the result is 
unfavorable to value as compared with prices in 
a large number of the active stocks. 

When a stock sells at a price which returns 
only about 3^ per cent, on the investment, it is 
obviously dear, except there be some special rea- 
son for the established price. In the long run, 
the prices of stocks adjust themselves to the 
return on the investment and while this is not a 
safe guide at all times it is a guide that should 
never be laid aside or overlooked. The tendency 
of prices over a considerable length of time will 
always be toward values. Therefore, the out- 



62 SCIENTIFIC STOCK SPECULATION. 

sider who by studying earning conditions can 
approach a fairly correct idea of value has a 
guide for his investments which will, as a whole, 
be found safe. 

Most people, however, when they talk about 
making money in stocks do not mean the slow 
road through investments but the short cut by 
way of speculation. We think here again there 
is one rule worth all others on this subject. It 
is a rule which is carried out with greater or less 
precision by a majority of successful traders. It 
has been approved by the practical experience of 
almost everybody who has dealt at all freely in 
stocks. 

This rule is to cut losses short but let profits 
run. It sounds very easy to follow, but is in 
reality difficult to observe. The difficulty arises 
from the unwillingness of an operator to take 
a small loss when experience shows him that in 
many cases such a loss need not have been taken. 
Furthermore, the practice of this rule suggests 
that having, for instance, bought a stock and 
taken a loss, the stock should be bought again, 
and this may have to be done three or four 
times before an advance finally comes. These 
three or four losses prove very burdensome and 
lead people oftentimes to decide not to cut the 
loss short and that is generally when a large loss 
ensues. 



SCIENTIFIC STOCK SPECULATION. 63 

The question will of course be asked whether 
there should be a uniform stop loss, or whether 
it should vary with varying conditions. Experi- 
ence indicates that two points is the wisest place 
to stop a loss. If a stock goes two points against 
the buyer, it is very liable to go more, and it 
suggests that the expected move has either been 
delayed or is not coming. 

Suppose, for instance, that an operator be- 
lieves from information, study of values, experi- 
ence in markets and the tendency of the period, 
that Union Pacific ought to be bought at 107. If 
he buys at that price and the stock falls to 105, 
theoretically he should cut his loss, buying it 
again when the indications are again favorable. 

Extended records of trading show that this 
policy, blindly followed, with blind following also 
of the plan of letting profits run, would give 
better results than most people are able to obtain 
by the exercise of judgment. At the same time, 
judgment can sometimes be wisely employed in 
cutting a loss. 

It is not, for instance, necessary in all cases 
to take a loss because the price is suddenly 
jammed down two points. If the market shows 
a tendency to rally, wait a little. If a decline 
in the stock bought is obviously due to a collapse 
in some other stock, and that collapse seems to 



64 SCIENTIFIC STOCK SPECULATION. 

have spent its force, it would be necessary to 
execute the stop. The idea is to stop the loss 
when the market has legitimately declined to 
that extent. 

In letting profits run there are two ways of 
determining when to close. One is to wait until 
the general market shows a decided change of 
temper. The other is to keep a stop order about 
three points behind the high prices on the ad- 
vance and close on that stop. Here, again, ex- 
perience has shown that when a stock starts on 
a manipulated advance, it is seldom allowed to 
react as much as three points until the move 
is completed. If it reacts three points, it may 
mean trouble with the deal, although there are 
cases where such reactions are allowed for the 
purpose of shaking out following. Here, again, 
something can be left to judgment. 

But the great thing is having bought a stock 
and having got fairly away from the purchase 
price, not to be in too great a hurry about sell- 
ing, provided that the general market is bullish. 
In a bear market, the whole proceeding ought 
to be reversed, the operator taking the short side 
instead of the long, but in other respects applying 
the same rule. 

We do not wish to be understood as saying 
that there is any sure way of making money 



SCIENTIFIC STOCK SPECULATION. 65 

in stocks, but the principle of buying after a 
period of steadiness in prices, stopping losses and 
letting profits run will, as a matter of statistical 
record, beat most people's guessing at what is 
going to occur. (S e 9.) 

Note 9. — While the principles stated in the latter 
part of this chapter are as good today as they were 
in 1902 the great broadening out of the market since 
then, the changed status of industrial issues and the 
number of high-priced stocks which are actively traded 
in, make the actual application of the principles subject 
to considerable modification. 

In General Motors, for example, an issue which 
has unquestionable value behind it and which, at this 
writing, has an active market around 240, a two-point 
stop order would be absurd. In fact, there is often a 
gap of about two points between the bid and offered 
prices. Nevertheless, over 10,000 shares a day are being 
traded in. A stop order can be executed in this issue 
without much difficulty, but it would have to be placed 
farther away from the purchase price. 

Baldwin Locomotive, again, is selling around 110 and 
ha^ a close market, so that stops can be readiiy 
executed. But its usual fluctuations are too wide to 
make a two-point stop practicable, unless in a very 
quiet market. 

Both stop orders and the averaging principle must 
be modified according to the nature of the stock 
traded in. 



CHAPTER X. 
The Out of Town Trader. 

A CORRESPONDENT asks: "How can a 
man living at an interior city, where he 
sees quotations only once or twice a day, 
make money by trading in stocks?" 

This question touches a point which seems to 
find wide-spread acceptance, namely, that prox- 
imity to Wall Street is a special advantage in 
trading. It certainly is for some kinds of trad- 
ing. If a man owns a seat on the Stock Ex- 
change and pays no commissions, he can probably 
do best by operating for his own account on the 
floor of the exchange, although not every man 
with these facilities is able to make his profits 
exceed his losses. 

For practical purposes, it may be said that 
most traders in or out of Wall Street are handi- 
capped by the commission of $25 for buying and 
selling 100 shares of stock. There probably are 
ie evasions of the commission rule, but as 
far as individual operators are concerned, com- 
missions are not much evaded. 

67 



68 SCIENTIFIC STOCK SPECULATION. 

A commission of $12.50 for buying and as 
much more for selling 100 shares of stock is in- 
significant if there are ten or even five points 
difference between the buying and selling price. 
But the commission is serious if the difference 
between the buying and the selling price is only 
one point. A man who started in to trade for 
one point profit and pays J/s commission would 
inevitably give all his money to his broker in the 
course of time. {See Note 10.) 

The ordinary operator must always endeavor 
to get comparatively large profits. He should not 

Note 10. — Present commission rates are $7.50 per 100 
shares for stocks selling under $10, $15 per 100 for those 
selling from $10 to $125, and $20 per 100 for those 
selling at $125 or more. There is also a $2 U. S. Gov- 
ernment tax and a $2 New York State tax on each sale 
of 100 shares, but no tax on purchases. 

The trader also has the handicap of the "invisible 
eighth" or quarter between the bid and asked prices. 
If the market is 88 bid, 88% asked, the buyer at the 
market will pay 88% while the seller at the market will 
get only 88. On such an issue the trader who buys 
and sells at the market really starts with a loss of 
$46.50 on 100 shares of a stock selling from $10 to $125 ; 
that is, this is the loss he would suffer if he bought and 
sold at exactly the same moment. 



SCIENTIFIC STOCK SPECULATION. 69 

buy unless he feels warranted in believing that 
the stock which he selects will go up four or five 
points, so that when he makes he will get double 
his loss when he loses. In trading for five or 
ten point turns, the operator at an interior city 
has one advantage. He does not hear the rumors 
and see sudden movements in prices which are 
the bane of the office trader. 

Wall Street is often full of people to-day who 
have been long of the market for a month, but 
who have made little or no money, because they 
have been scared out by rumors and by small 
relapses. The man who does not see the market 
escapes this. 

The greatest disadvantage resting upon the out 
of town operator is the fact that sometimes the 
market will change its character so rapidly as to 
convert a profit into a loss or establish a loss 
larger than he intended to take before he knows 
it. This, however, does not occur as frequently 
as most people seem to suppose. 

It is rather exceptional for the market, having 
run several points in one direction, to reverse 
the movement suddenly and without considerable 
fluctuations near the turning points. Such cases 
do occur, but they are unusual. {See Note II.) 
iTE 11. — These sudden turns are more common 
than they were in 1902. 



JO SCIENTIFIC STOCK SPECULATION. 

After a five-point rise, a stock usually has a 
period during which fluctuations are narrow and 
which are maintained long enough to give the 
out-of-town trader plenty of time to get out if he 
dislikes the appearance of the trading. Stop 
orders are the special protection of the out-of- 
town trader, who, if he will stick to stable stocks, 
can almost always cut his loss or save his profit 
at any spot where he deems wise. 

The out-of-town trader wants to begin his 
campaign w T ith a conviction that the stock which 
he buys is selling below its value. This should 
not only i>e a conviction, but a demonstrated con- 
viction, which cannot be shaken if, at the outset, 
the price declines instead of advances. Having 
determined on his stock from the viewpoint of 
value, he should, if possible, wait about buying 
until the general market has had its normal set- 
back from a high point. 

If twenty active stocks have advanced 10 
points, a normal setback would be four points, 
and then, in an extended period of rising prices, 
would be the time to make the initial purchase. 
The operator should then take in a great stock of 
patie.nce. He will see other stocks go -up and his 
stock stand still. He will see and hear daily that 
something else is making riches for traders, but 
he must shut his ears to these statements, even 



SCIENTIFIC STOCK SPECULATION. Jl 

if they are right as far as fluctuations go. He 
must just sit on his stock, which is intrinsically 
below its value, until other people observe that 
it is selling too low and begin to buy it. 

The tendency with most people holding a stock 
which does not move for a time is to sell the 
stock about as soon as it begins to move, through 
fear that it will again become dull. This is just 
the time not to sell, but, if anything, to buy more 
on the idea that other people have discovered that 
the price is below value. After the price has 
moved up two or three points, it is well to put in 
a stop order perhaps two points back from the 
top and follow the rise in the stock with the stop 
order, disregarding current reports and waiting 
until the price is either up to the value or until 
market conditions make taking a profit judicious, 
provided always that a sudden setback does not 
close out the transaction. 

An out-of-town operator can do all this just 
as well as an office trader and in some respects 
better. Some of the large operators like to go 
away from the market and work from Newport 
or Saratoga or other distant points in order to 
look at the trading with an unbiased mind and 
without being unsettled by the rumors that al- 
ways grow out of any special move. The out- 
sider who will wisely study values and market 



J2 SCIENTIFIC STOCK SPECULATION. 

conditions and then exercise patience enough for 
six men will be likely to make money in stocks. 



CHAPTER XL 
The Short Side of the Market. 

A CORRESPONDENT writes: "You dem- 
onstrate that an operator in stocks ought 
to work on the short side of the market 
during about half of almost every decade. I feel 
some hesitation about selling property which I 
do not own. Will you not make it clear how the 
short side of the market is normal trading ?" 

It is quite true that in each of the past four 
decades it would have been wise to work on the 
short side at least half of the time. It is also 
true that the public as a whole does not like short 
selling. It is true that corners occur at long in- 
tervals and are destructive to those caught 
therein. But they occur so seldom as to make 
them a very remote danger. There is about one 
in ten years. {See Note 12.) 

Xote 12. — Partial corners are far more common. By 
this is meant a condition of the market when the supply 
of stocks available in some issue becomes so small that 
only small amounts can be purchased without putting 
the price up far beyond the actual value. 

73 



74 SCIENTIFIC STOCK SPECULATION. 

We have explained the principle of short sell- 
ing many times, but will state the process once 
more. Customer X directs Broker A to sell 
short 100 shares of Union Pacific at par. Broker 
B buys it. A, not having the stock goes to 
Broker C, and borrows from him ioo shares of 
Union Pacific, giving as security $10,000 in cash. 
This stock is then delivered by A to B, who pays 
A $10,000 therefor. Matters then rest until Union 
Pacific advances or declines enough to make X 
wish to close his account. Pie then directs A 
to buy Union Pacific, say at 95, and A gets the 
stock from Broker D. The stock thus obtained 
is delivered to C, who thereupon returns the 
money which he has had as security and $9,500 
of the amount goes to D, leaving $500, less ex- 
penses, as the profit of X on the transaction. 

While X is waiting to see what the market is 
going to do C has the use of A's $10,000, and 
under ordinary conditions, pays interest on this 
money. This interest is called the loaning rate 
on stocks and is usually a little below the current 
rate for loans on collateral. 

The lower these rates are, compared with the 
rate for money, the more demand there is to bor- 
row that particular stock, and the loaning rate is 
the point to be watched by those who may be 
short, to see whether the short interest is large 
or small. 



SCIENTIFIC STOCK SPECULATION. 75 

demand to borrow a certain stock 
is very large, the loaning rate will be quoted flat, 
which means in the case cited that C would get 
the use of A's $10,000 without paying any in- 
terest. If the demand for the stock should be 
still greater, A might have not only to give C 
the Si 0,000 without interest, but a small premi- 
um in addition. When the loaning rate of stock 
is quoted at 1-32 it means that C gets his $10,000 
from A, without interest, and in addition a pre- 
mium of S3. 12 a day for each ioo shares, which 
has to be paid by X, who must also pay all divi- 
dends that may be declared on the stock. 

In ordinary lines of business, selling short with 
the idea of borrowing for delivery would be im- 
possible. In the stock market it is impracticable 
to sell distributed bonds or investment stocks 
short because such securities are held by inves- 
tors, and are not carried in quantity by brokers, 
hence, could not be readily borrowed. But, in 
active stocks, there is no difficulty whatever in 
borrowing. 

The reason is this: Every broker who carries 
many stocks employs a great deal more money 
than he possesses. In theory, a broker carrying 
for a customer 100 shares of Union Pacific at 
par would make up the money for the purchase 
000 belonging to the customer, $1,000 



j6 SCIENTIFIC STOCK SPECULATION. 

of the money of the brokerage firm, and then 
borrow $8,000 from a bank on the security of 
the 100 shares of stodc purchased. 

An active broker, consequently, is always a 
large borrower of money, and when he borrows 
from a bank he is expected to put up 20 per 
cent, margin on his loan. But if he can lend 
stocks he gets the full value of the stock and 
does not have to put up any of his own money 
or of his customer's money. Hence, every broker 
is willing to lend stocks, particularly when the 
demand for stock is sufficient to make the rate 
of interest lower than the market rate, as the 
broker in this case makes a profit by charging his 
customer who is long five or six per cent, interest, 
while he perhaps secures his money without any 
cost through lending the stock flat. 

This, from the standpoint of the short seller, is 
what makes his operation practically safe. Ordi- 
narily, it is just as easy to borrow active stocks 
as it is to borrow money, and squeezes of shorts 
through inability to borrow stocks are little if any 
more frequent than squeezes of "longs" through 
the difficulty of brokers in borrowing money. 

Squeezes of shorts sometimes develop them- 
selves and are sometimes manipulated. When 
friends of a property see a large short interest 
they sometimes try to persuade holders of the 



SCIENTIFIC STOCK SPECULATION. 7J 

stock to agree not to lend it for a day or two and 
thus scare shorts to cover by difficulty in borrow- 
ing. If this undertaking is successful brokers are 
notified to return borrowed stock, and when they 
try to borrow elsewhere they find little offering. 
The loaning rate possibly runs up to one-fourth 
per cent, a day, or perhaps higher. 

Shorts are alarmed and cover, advancing the 
price of the stock and enabling holders to sell at 
a profit. Such a squeeze usually lasts only two 
or three days, as by that time the advanced price 
leads those who have the stock to either sell it 
or lend it, and the price then usually goes lower 
than before. Sometimes there is a short interest 
so large and so persistent as to keep a stock lend- 
ing at a premium for some time. This is usually 
almost certain evidence of decline, but the ex- 
penses of premiums and the necessity of paying 
dividends sometimes eat up the profits so that but 
little remain even after considerable fall in price. 
Mr. Gould is said to have once remained short of 
New York Central over four years, and to have 
had a large profit as between his buying and his 
selling price, but to have had the greater part of 
it eaten up in dividends. 

In picking out a stock to sell short, the first 
consideration ought to be that the price is above 
value, and that future value appears to be shrink- 



78 SCIENTIFIC STOCK SPECULATION. 

ing. It should be an active stock and, if possible, 
a stock of large capital. It should be an old 
stock by preference, which means having wide 
distribution instead of concentrated ownership. 
By preference it should be a high priced stock 
with a reasonable probability that dividends will 
be reduced or passed. 

Such a stock should be sold on advances and 
bought in on moderate declines, say four or five 
points, as long as the market seems to be reason- 
ably steady. But, if the market becomes dis- 
tinctly weak, only part of the short stock "should 
be bought in with the hope that some short in- 
terest may be established at a price so high as 
to be out of reach of temporary swings. 

The best profits in the stock market are made 
by people who get long or short at extremes and 
stay for months or years before they take their 
profit. 



CHAPTER XII. 

Speculation for the Decline. 

THE question is frequently asked whether in 
taking a bearish view of the general market 
it is expected that all stocks will go down 
together or that some will fall and others not. 

The answer to this question takes two forms — 
the first is the speculative movement; the second 
the effect of values. When the market goes down, 
especially if the decline is violent or continued, 
all stocks fall ; not perhaps equally, but enough 
to be regarded as participating fully in a general 
decline. Indeed, it often happens that a stock of 
admitted large value will fall more in a panic 
than a stock of little value. 

The reason is that when people have been 
carrying various stocks, some good and some bad, 
and a time comes when they are obliged to sud- 
denly furnish additional margin or reduce their 
commitments, they try to sell the stocks for which 
they think the market will be best, namely, their 
best stocks. But the very merit of such stocks 
prevents the existence x>f a short interest, hence 
when considerable amounts are offered in a panic 

79 ' 



80 SCIENTIFIC STOCK SPECULATION. 

there is no demand for covering purposes, and, in 
fact, no demand except from investors who may 
have "resting" or "good until countermanded" 
orders in the hands of their brokers, or who may 
have money available for investment at that par- 
ticular moment. 

Consequently the stock drops until it meets 
an investment demand somewhere. This condi- 
tion was illustrated by the action of Delaware & 
Hudson in the panic of May 9, 1901. It had 
nearly, if not quite, the largest decline of any 
stock on the list, falling in half an hour from 160 
to 105, chiefly because people generally did not 
know the price at which stock was being offered. 

It may be accepted, therefore, that in a general 
decline merit in a stock will not count for the 
time being. Good and bad will decline measur- 
ably alike. But here comes in a marked distinc- 
tion. When the recovery comes, a day or a week 
later, the good stock will recover more and hold 
its recovery better than the poor stock. Dela- 
ware & Hudson is again a good illustration. 
After the quotation of 105 was printed on May 9 
orders to buy the stock came from all sections, 
and in another hour the price was in the neigh- 
borhood of 150. 

Value will always work out in the course of 
time. A stock intrinsically cheap and a stock 



SCIENTIFIC STOCK SPECULATION. 8l 

intrinsically dear may be selling at the same price 
at a given time. As the result of six months' 
trading they may have presented the appearance 
of moving together in most of the fluctuations, 
but at the end of the period the good stock will 
be 10 points higher than the poor one, the dif- 
ference representing a little smaller decline and 
a little better rally in each of five or six swings. 

This exactly describes what will occur all 
through the market during the next bear period, 
whenever that period comes. There will be a 
sifting of the better from the worse, visible 
enough at a distance, but not conspicuous at any 
particular stage in the process. 

When there is a great change in the value of 
a stock it will advance in a bear period. The 
market as a whole declined from 1881 to 18S5, 
but in that period Manhattan, while participat- 
ing in most of the market swings, went from the 
neighborhood of 30 to the neighborhood of par, 
because the increased earnings of the company 
increased value steadily and largely during that 
time. 

The practical lesson is that a stock operator 
should not deal in stocks unless he thinks he 
knows their value, nor unless he can watch con- 
ditions so as to recognize changes in value as 
they come along. He should then have at least 



82 SCIENTIFIC STOCK SPECULATION. 

a conviction as to what stocks are above their 
value and what are below their value at a given 
time. If the main tendency of the market is 
downward, he should sell stocks which he be- 
lieves to be above their value when they are very 
strong, taking them in on the next general de- 
cline. In buying for a rally, he should invariably 
take the stocks that are below their value, selling 
them also when a moderate profit is shown. 

When the market appears in a doubtful posi- 
tion it is sometimes wise to sell short a stock that 
is conspicuously above its value and buy a stock 
which is conspicuously below its value, believing 
that one will protect the other until the position 
of the general market becomes clear. It was for- 
merly very popular for traders to be long of 
Northwest and short' of St. Paul, usually with 
good results. 

During the past year (1901-2) there have been 
operators who have aimed to be long of Man- 
hattan and short of either Metropolitan or Brook- 
lyn on the same line of reasoning. The general 
method of operating such an account is to trade 
for the difference; that is, supposing a transac- 
tion to have been started with the two stocks 10 
points apart — the account is closed when they 
are, say, 15 points apart, assuring 5 points net 
profit. It is all, however, a part of the same 



SCIENTIFIC STOCK SPECULATION. 83 

general law. Stock fluctuate together, but prices 
are controlled by values in the long run. 






CHAPTER XIII. 
Concerning Discretionary Accounts. 



A CORRESPONDENT writes: "I inclose 
herewith a circular in which the sender 
asks me to give him a discretionary account 
promising large returns and claiming great suc- 
cess in past operations. A man in the market 
ought to be able to do better for me than I could 
df) for myself at a distance. Is this party reliable, 
and do you consider his scheme safe?" 

We get this letter in some form very often 
and have answered it many times, but it is dif- 
ficult to make people see the truth. Outsiders 
want to make money and they believe that people 
in Wall Street know what the market is going to 
do, hence that the only question involved in dis- 
cretionary accounts is the honesty of the men 
who run them. 

The fact is that people in Wall Street, even 
those who get very near the center of large oper- 
ations, do not know what the market is going to 
do with any regularity or certainty. The more 
they actually know, the less confident they be- 
come, and the large operators who try to make 

85 



86 SCIENTIFIC STOCK SPECULATION. 

markets are, in most cases, the least confident of 
anybody because they know so well the variety 
and extent of the difficulties which may be en- 
countered. 

People who trade in stocks can set down as 
a fundamental proposition the fact that any man 
who claims to know what the market is going 
to do any more than to say that he thinks this 
or that will occur as a result of certain specified 
conditions is unworthy of trust as a broker. Any 
man who claims that he can take discretionary 
accounts and habitually make money for his cus- 
tomers, is a fraud ; first, because he knows when 
he makes such statements that he cannot do it 
regularly or with certainty, and, second, because 
if he could, he would surely trade for himself and 
would scorn working for one-eighth commission 
when he could just as well have the whole 
amount made. 

The governors of the Stock Exchange will not 
permit a member of that body to advertise that 
he will take discretionary accounts, and any 
Stock Exchange member who stated that he was 
endeavoring to build up a business by discre- 
tionary trading for customers would lose caste 
with his fellow-members. It would be considered 
that he was either lacking in honesty or in judg- 
ment. 



SCIENTIFIC STOCK SPECULATION. 87 

We do not say that Stock Exchange houses 
never take a discretionary account. They some- 
times do, but they take them unwillingly in very 
limited amounts, only for people with whom they 
have very confidential relations and who under- 
stand speculation suffciently to expect losses 
and failures quite as frequently as profits. It is 
safe to say that Stock Exchange houses regard 
the acceptance of a discretionary account as a 
rather serious demand upon personal friendship, 
and this not because they do not wish to see their 
friends make money, but because they know too 
well that a discretionary account often means the 
loss of both money and friends. 

When, therefore, men of little or no capital 
and little or no reputation advertise boldly in the 
Sunday papers that they desire discretionary ac- 
counts from strangers and will, for a commis- 
sion of one-eighth per cent., guarantee profits 
ranging from 25 to 250 per cent, per annum, com- 
mission houses have but one word with which to 
describe the proposition and people of practical 
experience in Wall Street are amazed at the 
credulity of those who send their money to be 
placed in such accounts and who subsequently ap- 
pear in the company of those who wail in the 
outer rooms of closed offices over the rascality 
which has robbed them of their hard earnings. 



88 SCIENTIFIC STOCK SPECULATION. 

The head of a discretionary concern which 
was very prominent a year or two ago frequently 
said that if the United States Government would 
let his mails alone and deliver to him the money 
forwarded by his dupes he w T ould ask no better 
occupation and no quicker road to wealth. Evi- 
dence presented in court has shown repeatedly 
that swindlers who have advertised to make 
money for the public in speculation have received 
thousands of letters containing money; that none 
of this money was ever invested in stocks; that 
the advertisers were not members of any ex- 
change ^nd did not even pretend to have any busi- 
ness other than receiving and keeping the bulk of 
the money entrusted to their care. A small 
amount of the money received was usually re- 
turned to senders as profits on alleged transac- 
tions. 

This is substantially, we believe, the general 
practice. If a man sends $100 to one of the 
concerns, he is notified, after a little time, that 
he has made $10 and, a little later, that his share 
of a pool profit is $15. At this point he is usually 
advised to send $100 more on account of some 
extraordinary opportunity which has just arisen. 
If this money is sent, h£ is told that profits have 
accrued and still more money is called for. Per- 
sons who call for some of their profits are 



SCIENTIFIC STOCK SPECULATION. 89 

occasionally given money in order that the re- 
ceiver may induce others to join the list of future 
victims. 

The end, however, is almost, if not quite in- 
variably, a communication stating that by some 
adverse and utterly unexpected fatality opera- 
tions have been unsuccessful and the money 
invested has been lost. It is usually thought wise 
to make the victims appear somewhat in debt in 
order to induce them by not having to pay the 
alleged debt to accept as a mysterious dispensa- 
tion of Providence the loss of their capital and 
previous alleged profits. 

Speculation is not at its best a simple and easy 
road to wealth, but speculation through people 
who advertise guaranteed profits and who call 
for participation in blind pools is as certain a 
method of loss as could possibly be discovered. 
The mere fact that a man openly asks for such 
accounts is the most ample and exhaustive reason 
possible for declining to give them. 



CHAPTER XIV. 
The Liability for Loss. 

OF a number of inquiries lately the following 
is a sample: "I was long of stocks May 9, 
1 90 1, and was sold out. The broker now 
asks me to pay a loss in excess of my margin. 
Am I liable therefor?" 

This question has never been definitely settled 
as a matter of law. There have been a good many 
decisions in cases of this kind but they have gen- 
erally been sufficiently dissimilar to make each 
decision rest upon that particular case, and not 
as establishing a principle of law, bearing thereon. 

Cases of this kind generally fall under one of 
two general divisions. Either the broker notifies 
his customer that his margin is nearly exhausted, 
or he does not. It is probably good law to as- 
sume that where a stock is bought on margin and, 
on a fall in the price, the broker calls on the 
customer for more margin and there is no re- 
sponse within a reasonable time, the broker is 
justified in selling the stock without a positive 
order to do so from the customer. The courts 
have held in such cases that the broker gave 

91 



92 SCIENTIFIC STOCK SPECULATION. 

ample notice and the customer should have 
responded in time to protect his interests. The 
broker could not be expected to wait more than 
a reasonable time. 

In cases of this class it sometimes happens 
that the customer does not think it wise to put up 
more margin and orders the stock sold. It may 
be sold at a loss on account of a rapid decline in 
prices. In this case, there seems to be little doubt 
of the liability of the customer, because the 
broker is executing an order to sell for the 
account and risk of that customer. Here, how- 
ever, might enter special questions as to whether 
the broker was or was not negligent in notifying 
the customer that margin was needed, or in the 
execution of the order when it was received, or 
in some other respect whereby the interest of 
the customer was allowed to suffer. 

The other general class of cases is where 
margin on accounts is swept away by a sudden 
decline and the broker faces the question whether 
it is better to sell his customer's stock without 
an order or to endeavor to carry the customer 
through the decline with the expectation that the 
loss, if there is a loss, will be made good by the 
customer. 

The tendency of decisions in these cases is 
toward holding the broker to rather close ac- 



EENT1FIC STOCK SPECULATION. 93 

countability for his actions. The point has been 
made that the broker in such a case is acting in 
a double capacity. First, as a broker executing 
an order for a customer for a commission. Sec- 
ond, as a banker in making a loan to this custo- 
mer, being protected therein by the security of 
money deposited and the possession of the stock 
purchased. As a broker, the equity might be one 
way, while as a banker it might be exactly op- 
posite. 

Generally speaking, a banker has no right to 
-sell out a loan without notifying the borrower. 
except where there has been a special agreement 
permitting such action. This fact leads banks 
and institutions in nearly all cases to make loans 
with a formal agreement authorizing them to 
sell the collateral at their option in case, the loan 
ceases to be satisfactory. As a matter of prac- 
tice, banks call for more collateral when prices 
decline. But in cases of panic, or the inability 
of brokers to furnish more collateral, loans are 
frequently sold out, under the special agreement 
to that effect. 

Some commission houses protect themselves 
by a formal agreement with customers similar to 
that required by banks. When a customer opens 
an account, he cement authorizing 

the broker to sell the stock bought at his dis- 



94 SCIENTIFIC STOCK SPECULATION. 

cretion in case the margin runs down to the dan- 
ger line. 

This is undoubtedly a wise method, as it 
removes all doubt as to the position of each party 
in the premises. Such agreements are not in- 
variably made because in the competition for 
business brokers do not like to impose restrictions 
which are not universal and which may have a 
tendency to drive away custom. Nevertheless, 
experiences like those of the 9th of May, have 
a decided tendency toward defining the relations 
between broker and customer. 

The action of the market May 9 was so rapid 
as to make it impossible for a broker to notify 
a customer of the need of more margin and get 
a response in time to be of any use. A 10-point 
margin was of no use at a time when stocks were 
falling 10 points in five minutes. There were 
many cases that day in which wealthy commis- 
sion houses saw a large percentage of their cap- 
ital disappear in customers' accounts between 11 
and 11 :3c The rapidity of the recovery was all 
that saved multitudes of customers and many 
commission houses. Loans, small and large, were 
unsound and sound again before lenders had 
time to sell even if they had been disposed to 
do so. 

There were, however, many cases where stocks 



SCIENTIFIC STOCK SPECULATION. 95 

were sold entailing large losses and the loca- 
tion of these losses is in a number of cases still in 
legal controversy, with the probability that the 
decision will turn more or less upon the circum- 
stances peculiar to each case. The 9th of May 
was a very extraordinary day and allowance 
must be made for its unusual character. Stock 
Exchange rules based on the occurrences of the 
gth of May would prohibit doing business under 
ordinary conditions, but such days come and on 
this account brokers and customers should make 
provision for the unexpected by a clear under- 
standing as to what shall be done in emergencies. 
It is often difficult to say what shall be done 
when a loss has occurred through unusual condi- 
tions and under circumstances which made the 
action taken largely discretionary. This fact in 
its application to the May panic has led brokers 
and customers in cases to adopt a policy of 
trying to divide the loss equitably and with due 
reference to the facts involved in that particular 
case. A jury familiar with Stock Exchange busi- 
ness would be very likely to render a decision 
along somewhat similar lines. 



A 



CHAPTER XV. 

The Recurrences of Crises. 

CORRESPONDENT writes: "Is it true 
that commercial or stock exchange panics 
are approximately periodic in their occur- 



The facts point distinctly in that direction, 
and there is reason back of the facts. The 
reason is that the business community has a 
tendency to go from one extreme to the other. 
As a whole, it is either contracting business 
under a belief that prices will be lower or ex- 
panding under a belief that prices will be higher. 
It appears to take ordinarily five or six years 
for public confidence to go from the point of too 
little hope to the point of too much confidence 
and then five or six years more to get back to 
the condition of hopelessness. 

This ten-year movement in England is given 
in detail by Professor Jevons in his attempt to 
show that sun spots have some bearing upon 
commercial affairs. Without going into the mat- 
ter of sun spots and their bearing upon crops, 
commerce, or states of minds, it may be assumed 
that Professor jevons has stated correctly the 

97 



98 SCIENTIFIC STOCK SPECULATION. 

periods of depression as they have occurred in 
England during the last two centuries. 

The dates given by him as the years in which 
commercial crises have occurred follow: 1701, 
171.1, 1712, 1731-2, 1742, 1752, 1763, 1772-3, 
1783, 1804-5, 1815, 1825, 1836, 1847, 1857, 1866 
and 1878. 

This makes a very good showing for the ten- 
year theory, and it is supported to a considerable 
extent by what has occurred in this country 
during the past century. 

The first crisis in the United States during the 
nineteenth century came in 1814, and was pre- 
cipitated by the capture of Washington by the 
British on the 24th of August in that year. The 
Philadelphia and New York banks suspended 
payments, and for a time the crisis was acute. 
The difficulties leading up to this period were the 
great falling off in foreign trade caused by the 
embargo and non-intercourse act of 1808, the 
excess of public expenditures over public re- 
ceipts, and the creation of a large number of state 
banks taking the place of the old United States 
bank. Many of these state banks lacked capital 
and issued currency without sufficient security. 

There was a near approach to a crisis in 1819 
as the result of a tremendous contraction of 
bank circulation. The previous increases of bank 



SCIENTIFIC STOCK SPECULATION. 99 

issues had promoted speculation, the contraction 
caused a serious fall in the prices of commodi- 
ties and real estate. This, however, was purely 
a money panic as far as its causes were con- 
cerned. 

The European crisis in 1825 caused a dimin- 
ished demand for American products and led to 
lower prices and some money stringency in 1826. 
The situation, however, did not become very 
serious and was more in the nature of an inter- 
ruption to progress than a reversal of conditions. 

The year 1837 brought a great commercial 
panic, for which there was abundant cause. 
There had been rapid industrial and commercial 
growth, with a multitude of enterprises estab- 
lished ahead of the time. Crops were deficient, 
and breadstuff's were imported. The refusal of 
the government to extend the charter of the 
United States Bank had caused a radical change 
in the banking business of the country, while the 
withdrawal of public deposits and their lodgment 
with state banks had given the foundation for 
abnormal speculation. 

The panic in Europe in 1847 exerted but little 
influence in this country, although there was a 
serious loss in specie, and the Mexican war had 
some effect in checking enterprises. These effects, 
however, were neutralized somewhat by large 



IOO SCIENTIFIC STOCK SPECULATION. 

exports of breadstuffs and later by the discovery 
of gold in 1848-9. 

There was a panic of the first magnitude in 
1857, following the failure of the Ohio Life In- 
surance & Trust Company in August. This 
panic came unexpectedly, although prices had 
been falling for some months. There had been 
very large railroad building, and the proportion 
of specie held by banks was very small in pro- 
portion to their loans and deposits. One of the 
features of this period was the great number of 
failures. The banks generally suspended pay- 
ments in October. 

The London panic in 1866 precipitated by the 
failure of Overend, Gurney & Co., was followed 
by heavy fall in prices in the Stock Exchange 
here. In April there had been a corner in Michi- 
gan Southern and rampant speculation generally, 
from which the relapse was rather more than 
normal. 

The panic of September, 1873, was a com- 
mercial as well as a Stock Exchange panic. It 
was the outcome of an enormous conversion of 
floating into fixed capital. Business had been ex- 
panded on an enormous scale, and the supply of 
money became insufficient for the demands 
made upon it. Credit collapsed and the depres- 
sion was extremely serious. 



SCIENTIFIC STOCK SPECULATION. IOI 

The year 1884 brought a Stock Exchange 
smash but not a commercial crisis. The failure 
of the Marine Bank, Metropolitan Bank and 
Grant & Ward in May was accompanied by a 
large fall in prices and a general check which 
was felt throughout the year. The Trunk Line 
war, which had lasted for several years, was one 
of the factors in this period. 

The panic of 1893 was the outcome of a num- 
ber of causes — uncertainty in regard to the 
currency situation, the withdrawal of foreign 
investments and the fear of radical tariff legisla- 
tion. The anxiety in regard to the maintenance 
of the gold standard was undoubtedly the chief 
factor, as it bore upon many others. 

Judging by the past and by the developments 
of the last six years, it is not unreasonable to 
suppose that we may get at least a stock exchange 
flurry in the next few years. This decade seems 
to be the one for the small crisis instead of the 
large one — a type of 1884 rather than a recur- 
rence of 1837, 1873 or I 893- (See Note 13.) 

Note 13. — Mr. Dow's forecast here was verified by 
the "undigested securities" panic of 1903, which was 
confined almost entirely to investments, business in 
general suffering but little. Later panics came in 1907 
and 1914. 



lfrUJkV9 . 
& 111 



